Unit 4
SOCIAL INTERACTIONS
OUTLINE
A. Introduction
B. Game Theory: Key concepts
C. Resolving social dilemmas
A. Introduction
The Context for This Unit
• Previous models of choice did not depend on others’
(Unit 3)
decisions.
• Individuals motivated by self-interest can produce
outcomes that are beneficial for society e.g.
entrepreneurship, innovation.
(Unit 1)
• However, self-interest can also be harmful to society.
• Why do these problems arise?
• What can we do about it?
This Unit
Use the tools of game theory to model social interactions
and explain social dilemmas
Social dilemma = a situation in
which actions taken
independently by self-interested
individuals result in a
socially suboptimal outcome e.g.
traffic jams, climate change
This Unit
Social dilemmas occur when people do not fully account
for the effects of their actions on others.
• Tragedy of the Commons: Common property or common
resources are often overexploited
• Free riding: One person/party bears all the costs while
everyone enjoys the benefits
How can altruism and government policy resolve social dilemmas?
B. Game theory: Key concepts
Social and Strategic Interactions
• Social interaction: A situation involving more than one
person/party, where one’s actions affect both their own
and other people’s outcomes.
• Strategic interaction: A social interaction where people are
aware of the ways that their actions affect others.
• Strategy: Action(s) that people can take when engaging in a
social interaction.
Game
• A game describes a social interaction:
1. Players – who is involved in the
interaction
2. Feasible strategies – actions each
player can take
3. Information – what each player
knows when choosing their action
4. Payoffs – outcomes for every
possible combination of actions
Example: Crop choice
• Two farmers decide which crop to
specialize in.
• They interact only once (one-shot game).
1. Players – Anil and Bala.
2. Feasible strategies – Rice or Cassava
3. Information – Each farmer does not
know what the other chose.
4. Payoffs – depend on market prices
and quality of land.
Optimal decision-making
• Best response: Strategy that yields the
highest payoff, given the other player’s
strategy
• Dominant strategy: A best response to all
possible strategies of the other player (does
not always exist!)
• Dominant strategy equilibrium: An
outcome of a game in which everyone plays
their dominant strategy
Crop choice example
• Best response: If Bala grows rice, Anil’s best
response is to grow cassava. If Bala grows
cassava, Anil’s best response is to grow
cassava.
• Dominant strategy: Anil’s dominant
strategy is to grow cassava. Bala’s dominant
strategy is to grow rice.
• Dominant strategy equilibrium: When Anil
and Bala each play their dominant strategy,
the outcome is (Cassava, Rice).
Nash equilibrium
Nash equilibrium: A set of strategies
(one per player), such that each
player’s strategy is the best response to
the strategies chosen by everyone else.
In a Nash equilibrium, no player has an
incentive to deviate unilaterally.
NOTE: There may be more than one
Nash equilibrium in a game.
Different pay-offs
C. Resolving social dilemmas
The Prisoners’ Dilemma
Prisoner’s Dilemma = A game with a
dominant strategy equilibrium, in which
playing the dominant strategy
yields lower individual and total payoffs
compared to other strategies
Socially optimal outcome is not achieved
Pesticide example: Both farmers choose
to use the more harmful pest control (T).
Why did we predict this outcome?
1. Players only care about their own payoffs.
• Introduce social preferences
2. Nobody could make players pay for the consequences of their
actions on others.
• Introduce repeated games, social norms, and peer punishment
3. Players could not coordinate their actions beforehand
• Change the rules of the game (institutions and policies)
Learning about preferences
Economists sometimes use experiments to learn about preferences.
1. Lab experiments:
• Can control participants’ decisions and their outcomes.
• Can create a control/treatment group for comparison.
• Results can be replicated.
• Can control for other variables.
2. Field experiments:
• Lab experiments may not predict real-world decision making.
• More realistic context in which people make decisions.
Social preferences: Altruism
• Social dilemmas arise when
players only care about their own
payoffs.
• However, in experiments, many
players show altruism by choosing
the dominated strategy.
• Altruistic preferences affect the
shape of indifference curves.
Resolving the Prisoners’ Dilemma
Pesticide example: If Anil is somewhat altruistic,
then his dominant strategy is I instead of T.
Social preferences: Other types
• Inequality aversion: Disliking outcomes in which some
individuals receive more than others
• Reciprocity: Being kind/helpful to others who are kind/helpful,
and vice versa.
• We evaluate whether others have been ‘kind’ or ‘helpful’
according to social norms (common understanding of how to act
in situations when one’s actions affect others).
These motives affect outcomes in the public goods game and the
ultimatum game.
Repeated Games
• We have so far looked at one-shot games.
• Better outcomes can arise in repeated interactions due to
social norms, reciprocity, and peer punishment.
• Behaving selfishly in one period has consequences in future
periods, so it may no longer be a dominant strategy.
Public goods game: Farming example
• There are a group of farmers.
• Each farmer decides whether
to contribute to the public
good (e.g. irrigation project).
• Contributing has a personal
cost, but everyone benefits.
Prisoner’s dilemma with more than two people:
Not contributing (free riding) is a dominant strategy.
Reciprocity and Social Norms
In public goods experiments, people were happy to contribute as long
as others reciprocate. Contributions differ according to social norms.
Peer Punishment
The ability to identify and punish free-riders
also increases individual contributions.
The Ultimatum Game
A sequential game where players
choose how to divide up
economic rents e.g. cash prize
The proposer’s offer may be
motivated by altruism,
fairness (50-50 split),
inequality aversion,
social norms, or reciprocity.
Example: Kenyan farmers and US students
Offers are consistent with social preferences, but also with
expected payoff maximization
The rules of the game matter
Introducing competition between responders moves outcomes
closer to the self-interested outcome
Coordination issues
When there is more than one Nash
equilibrium and individuals choose
independently, the socially optimal
outcome may not be selected.
Society could be “stuck” in a suboptimal
outcome since there is no incentive to
unilaterally change one’s action.
Example: Climate change
Outcomes depend on rules and preferences
• Business as usual (BAU) is the
dominant strategy for purely
self-interested players
• An emissions treaty would produce
the socially optimal outcome
• Inequality aversion and reciprocity
will result in two Nash equilibria here
which include the social optimum
Summary
1. Social interactions can be modeled as games
• Players choose best responses to others’ strategies
2. Social dilemmas e.g. prisoners dilemma can be resolved by
social preferences, peer punishment, or binding agreements
• The rules of the game also matter for outcomes
3. Multiple Nash equilibria can cause coordination problems
• Economic and political institutions can help achieve socially
optimal outcomes
In the next unit
• The role of institutions in social allocations
• How to evaluate social outcomes: efficiency and fairness
• How bargaining power affects the distribution of surplus